What a poor credit rating is costing you

The week after Christmas isn’t just a time for cruising the post-holiday sales. For some, it’s when the realization of all that spending over the last month kicks in.

If the post-holiday bills aren’t enough, perhaps a look at the cost of a poor credit score will also help you mend your ways.

Experts estimate that a less-than-sterling credit score can cost you tens of thousands of dollars over the years, since you’ll be paying higher interest rates on everything from mortgages to a Macy’s credit card—if you can even obtain those things.

“If your credit score is high enough, you’ll qualify for a lender’s best rates and terms. Your mailbox will be stuffed with low–rate offers from credit card issuers, and mortgage lenders will fight for your business,” personal finance expert Liz Weston wrote in her book Your Credit Score: How to Improve the 3–Digit Number That Shapes Your Financial Future. “If your score is low or nonexistent, however, you’ll enter a no-man’s land where mainstream credit is all but impossible to come by.”

That no-man’s land may be closer than you think. The mortgage market is a case in point. According to Ellie Mae, an electronic network for mortgage origination, the average credit score for people taking out mortgages in November was 729. That’s down from 750 a year earlier, but still high compared to historical averages.

The cost of a mortgage will increase the further your score falls below that level, said Rod Griffin, director of public education at Experian. “If your interest rate increases by 1 percent or 2 percent on a mortgage over the course of a 30-year loan, that can cost you tens of thousands of dollars,” he said. “A poor credit score can cost you several percentage points in a mortgage loan.”

A truly low score can make it impossible for you to obtain credit at any rate. Insurance companies may refuse to issue you policies. And while Sen. Elizabeth Warren, D-Mass., has introduced legislation to make the practice illegal, for now employers can use credit scores to evaluate job applicants.

“By some estimates, fewer than 10 percent of people eligible for a free annual credit report actually get it,” he said. “Every credit score is based on the information in that credit report.”

There is always a chance that you have an error on your credit report, and you should do everything you can to get that cleared up. The Federal Trade Commission issued a report earlier this year saying that 5 percent of consumers had errors on their credit reports that were significant enough to affect the rating itself.

If your report is accurate, and you don’t like what it says, a few simple steps can make a big difference. First and foremost, “pay all your bills on time, every single time,” Griffin said. He estimates that your bill-paying behavior accounts for 30 to 40 percent of your credit score.

Second, keep your use of credit in check. Roughly another third of your credit score comes from how big your balances are on credit cards and other credit lines, relative to your credit limits—what industry people call your utilization rate. Griffin says zero balances are best, but it is essential to use no more than 30 percent of the credit available to you on credit cards and other credit instruments.

“Also look at your utilization on individual credit card accounts,” he warns. “You may have a total utilization rate that’s low, but if you have one card that’s maxed out, that is a negative.”

Big financial problems in your past like a bankruptcy or a short sale of a home can take years to clean up in your credit report. But if your history is generally excellent, and you’ve just had a few screwups, mending your ways may lift your credit score quickly.

“Scorers recognize that’s an anomaly,” Griffin said. “If you have a few late payments, catch up and start making payments on time. It could be a few months.”